The Bank of England's Financial Policy Committee has flagged a substantial increase in hedge fund leverage in equity markets as a systemic vulnerability, warning that the probability of multiple risks materialising concurrently has risen since its December 2025 assessment. The FPC's July 2026 Financial Stability Report identifies growing concentration in AI-related stocks, stretched valuations, and interconnected exposures via prime brokers as flash points that could amplify shocks across global markets.
Deputy Governor for Financial Stability Sarah Breeden presented the findings at a press conference on 7 July 2026, noting that despite the resilience demonstrated by the UK financial system during the macroeconomic shock associated with conflict in the Middle East, structural vulnerabilities in risky asset valuations and credit markets have become more pronounced. The Committee's assessment emphasises that the financial system has remained resilient and continued to support the UK real economy, underlining the benefits of resilience that has been built into the system.
The report documents that equity prices have increased especially for AI-related stocks, with global equity indices driven in part by continuing positive earnings news since the December Financial Stability Report. However, valuations have become more stretched on some metrics, and rising equity prices have been driven by a narrow set of AI-related companies, increasing market concentration in some global indices. The FPC notes that there has been a significant rise in hedge fund leverage in equity markets, creating risks including via the prime brokers which facilitate this activity and through markets that are interconnected via hedge funds' exposures, such as sovereign debt.
The confluence of leverage and concentration presents particular challenges for portfolio managers. Retail inflows, including via exchange traded funds, may have added momentum to the rise in equity prices, according to the report, and there has also been rapid growth in assets under management of levered ETFs. The Committee observes that developments in the Middle East have affected the global risk environment materially, with energy and some other commodity prices, as well as sovereign bond yields, experiencing volatility and initially rising sharply above pre-conflict levels.
Market interest rates globally, including in the UK, have risen, thus tightening financial conditions, while risky asset prices have reached high levels. The signing of the Memorandum of Understanding between the US and Iran has led energy prices to fall back to just above pre-conflict levels, reducing near-term risks, and sovereign bond yields have also declined. However, substantial uncertainty remains and energy prices and interest rate markets have remained volatile, the FPC notes.
Leverage that threads through prime brokers and into sovereign debt markets is risk that compounds inside a sleeve until it screams across the portfolio, family office advisor Jaf Glazer has maintained.
On the credit side, AI-related companies' use of credit markets has accelerated rapidly, including in public markets, private credit, leveraged and structured finance, and is set to increase further as financing needs continue to expand. The pace of investment is unprecedented historically, according to the report. As of yet, there is little evidence that AI activity in these markets is crowding out the ability of other businesses or governments to access funding markets, the Committee observes.
The FPC acknowledges that AI has the potential to raise productivity across a range of sectors and, in turn, support long-term economic growth. Developments in AI have already provided a tailwind to growth in some regions, but there is uncertainty over the scale and timing of future productivity gains and the ability of companies to monetise these. Separately, recent rapid advances in frontier Artificial Intelligence capabilities have increased financial stability risks related to cyber and operational resilience, the report warns.
The Committee's assessment is that persistent vulnerabilities in the financial system previously identified by the FPC could interact with further developments in the Middle East. In addition, leverage has increased in equity markets. The likelihood of these vulnerabilities crystallising at the same time has increased since the December Financial Stability Report, potentially amplifying their combined impacts on financial stability. UK households and businesses are resilient, and the banking system is strong enough to support them in a stress, the FPC concludes, though it continues to monitor the cluster of risks that have become more tightly coupled since the end of 2025.